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The euro is trading near $1.16 at the start of the week, as markets await the European Central Bank’s interest rate decision on Thursday. Meanwhile, oil prices are approaching $100 a barrel, and strong US jobs data is reviving expectations of a Federal Reserve rate hike. Despite a repricing of global interest rate expectations in recent days, the EUR/USD pair has remained relatively calm, reflecting a balance of opposing forces pushing the European currency in different directions.
The euro awaits Thursday’s decision
The EUR/USD pair held steady near the $1.16 level on Monday, with the euro showing limited movement despite significant shifts in global interest rate expectations. This calm stems from a conflict between two key factors. On the one hand, markets are widely anticipating a European Central Bank (ECB) interest rate hike this week, which could provide additional support for the euro.
On the other hand, Friday’s US jobs data came in much stronger than expected, boosting the appeal of dollar-denominated assets and raising expectations that US interest rates will remain high. Markets anticipate that the European Central Bank will raise its deposit rate by 25 basis points to 2.50% at its meeting on Thursday. This would be the second rate hike since June, when European policymakers began to take a more serious stance on inflationary pressures linked to rising energy prices.
European inflation rises again
This potential move comes at a time when European inflation data shows a return of price pressures. Inflation in the eurozone rose to 3.3% in August , compared to 2.9% in July, driven mainly by higher energy prices. But the picture becomes more complex when looking at core inflation, which excludes the more volatile food and energy prices.
Core inflation has fallen to 2.4% , suggesting that much of the recent rise in inflation stems from the energy shock rather than broader price pressures within the economy. This presents the European Central Bank with a difficult dilemma: higher energy prices are driving inflation upward, but at the same time, they are squeezing household purchasing power and corporate profit margins.
Oil presents the European Central Bank with a dilemma
Brent crude approached $97 a barrel after the attacks between the United States and Iran around the Strait of Hormuz over the weekend. The developments led to a sharp decline in shipping traffic through this vital waterway, raising concerns that the disruption to energy supplies could last longer. Europe is considered more vulnerable to this shock than some other economies due to its heavy reliance on energy imports.
Therefore, the continued rise in oil prices poses a direct threat to European households and businesses, but it also raises inflation rates, which could prompt the European Central Bank to maintain a tighter monetary policy. The decision to raise interest rates itself is already priced in by the markets , and thus may not be the primary driver of the euro’s movement on Thursday. The focus will likely be on the remarks of ECB President Christine Lagarde and what she says about the next steps. If her comments are hawkish and indicate the possibility of further interest rate hikes, European bond yields could rise, providing the euro with additional support.
However, if the message carries a more cautious tone, suggesting that the rate hike will be a one-off and that the bank does not intend to continue tightening, the euro could come under pressure despite the rate increase itself. On the other side of the Atlantic, the strong US jobs report has put the dollar back in the picture.
The US economy added 162,000 jobs in August , nearly three times the expected 56,000, while the unemployment rate held steady at 4.1% .
These data have led to increased expectations of a US interest rate hike at the Federal Reserve meeting next week, with markets pricing in a near 57% probability of an increase . Markets are now awaiting US inflation data, with the Producer Price Index (PPI) due on Thursday , followed by the Consumer Price Index (CPI) on Friday .
If US inflation data comes in strong, bets on an interest rate hike could receive an additional boost, potentially pushing the euro below $1.16 and opening the way for it to test support levels at $1.1550 and then $1.1500 . Conversely, if inflation data falls short of expectations, bets on a US rate hike could be dealt a blow, and the dollar could weaken, giving the EUR/USD pair a chance to move back towards $1.1660 and then $1.1700 .
Why didn’t the dollar rise strongly despite the strong jobs situation?
Ironically, the dollar did not benefit as much as expected from Monday’s strong jobs report and rising interest rate hike expectations. This may be because investors are beginning to consider the bigger picture. Concerns about the state of the US fiscal position, coupled with the potential inflationary impact of the Gulf conflict and rising energy prices, could limit demand for the dollar despite the improved interest rate outlook.
Therefore, the strength of the US economy is no longer the sole factor determining the direction of the currency. Markets are simultaneously monitoring inflation, bond yields, oil prices, the financial situation, and monetary policy .
The euro currently stands at a delicate equilibrium point.
On the one hand, the European Central Bank is preparing to raise interest rates to 2.50% , while European inflation has risen to 3.3% as a result of the energy shock, which could support the continuation of a tight monetary policy. On the other hand, the US economy has proven more resilient than expected, adding 162,000 jobs, which has brought the possibility of a US interest rate hike back into focus.
But the factor that could determine the movement of the Euro/Dollar in the coming days will not be the European interest rate decision alone.
Christine Lagarde’s remarks on Thursday and the US inflation data on Friday may prove more significant than the interest rate hike decision itself. If a hawkish tone from the European Central Bank is coupled with weak US inflation, the euro could have a chance to break through $1.17. However, if the US inflation data is strong, coupled with a cautious tone from Lagarde, pressure could return on the euro, making a break below $1.16 the more likely scenario. In the background, oil remains the variable that could upset all calculations, especially if Brent crude approaches $100 per barrel .
